UNIT 9 MONOPOLISTIC COMPETITION

Structure
9.0 Objectives
9.1 Introduction
9.2 Features of Monopolistic Competition
9.3 General Approach to Equilibrium
9.3.1 Short-run Equilibrium
9.3.2 Long-run Equilibrium
9.4 Chamberlain’s Approach to Equilibrium
9.4.1 Model 1
9.4.2 Model 2
9.4.3 Model 3
9.5 Selling Costs
9.6 Excess Capacity under Monopolistic Competition
9.7 Criticism of Monopolistic Competition
9.8 Let Us Sum Up
9.9 Key Words
9.10 Some Useful Books
9.11 Answers to Check Your Progress
9.12 Exercises

9.0 OBJECTIVES
On going through this unit you will :
• understand the monopolistic competitive market structure;
• know the equilibrium of the market structure; and
• appreciate the social aspect of excess capacity creation and optimal
output production.

9.1 INTRODUCTION
The earlier units (Perfect Competition) and (Monopoly) dealt with two
‘extreme’ cases of market structure. In reality, there are hardly few markets,
which fit into such kinds of framework. Therefore, in the late 1920’s economists
became increasingly dissatisfied with the use of these market structures as
analytical models of economic behaviour. The assumptions of perfect
competition, mainly the assumption of homogenous products, did not resemble
the real word. Sraffa, Chamberlin and Joan Robinson worked individually to get
some alternatives to fit into the real word. The revolutionary book Chamberlin
introduced a new market structure with the flavour of both competition and
imperfection. He called this new market structure monopolistic competition.

9.2 FEATURES OF MONOPOLISTIC

COMPETITION
1) Product Differentiation
The theory of monopolistic competition is based on solid empirical fact that
there are very few monopolists because there are very few commodities for
which close substitutes do not exist. Similarly, there are very few
commodities, which are entirely homogeneous. 41
Price and Output Consider the market of detergent powders in India. The products of “Ariel and
Determination - I
Surf” are not the same entities. Thus, in a sense they have monopoly character
because they are the sole supplier of their respective products. However, since
their products are close substitute of each other, they share the market of
detergent powder.
Thus, in reality products of different producers are heterogeneous. Along with
that, products of the same industry are close substitutes of each other.
Producers make their products different from others consciously so that their
products to remain unique.
There are many ways in which products could be differentiated. They might
differ according to chemical composition, appearance, brand name,
advertising, packing material etc.
2) Industries and Product Groups
In perfect competition, industry was defined as a collection of firms producing
a homogeneous product. However, when each product is differentiated, one
cannot define an industry by the above definition. We will call the firms
producing close substitutes as product groups. For example, firm producing
soap, shampoo and cigarette cannot be called industries
However, there is a problem in defining a product group. It is not precisely
defined when firms enter a product group because the degree of
substitutability is a relative concept. Chewing gum could be a substitute for
cigarette for those who are trying to quit smoking but firms producing
chewing gum would never enter the product groups of cigarette. Similarly, tea
and coffee may be close substitutes. However, they do not enter the same
product group. According to Chamberlin, ‘product groups’ should include
products, which are close technological and economic substitutes. To him
logical substitutes are those products, which can technically cover the same
want, and economic substitutes are those products, which satisfy the some
want and have similar price structure. An operational definition of product
group is that the demand for each single product is highly elastic and it shifts
appreciably when the prices of other products in the group change. In other
words, products forming the group should have high price and cross
elasticities.
3) Free Entry and Exit
Like perfect competition, firms may enter and leave the product group at their
will. If the firms in the product group are earning supernormal profit, new
firms will enter lured by the profit. Similarly, if existing firms are making
looses, firms will quit.
4) Number of Buyers and Sellers
There are a large number of buyers and sellers in a monopolistic completive
market
5) Non-Price Competition
Since the products are slightly differentiated, in order to increase the demand
for their products firms engage themselves in non-price competition, such as
advertising or adding up some frills (free gifts etc.).
6) Independent Behaviour
The economic impact of one firm’s decision is spread sufficiently evenly
across the entire group so that the effect on any single competitor goes
unnoticed. This implies rivalry is missing and competition is impersonal.
42
 Monopolistic
9.3 GENERAL APPROACH TO EQUILIBRIUM Competition

As we defined earlier the grouped demand curve (demand) curve of the

products which are close substitutes of each other) is negatively sloped. This
grouped demand curve must somehow be divided up among the members of
the group. All the firms in the group are identical, facing similar demand and
cost conditions. If all charge the same price, they will have identical market
shares.

Dg
Df

Dp

X
O X
Fig. 9.1: Group Demand Curve in Monopolistic Competition
In the figure above, Dg is the grouped demand curve and Dp is the
proportionate demand curve (when all the firms charge the same price). Dp is
obtained horizontally dividing Dg by the number of firms.
A firm, however, does not perceive Dp to be its demand curve. If the current
price is P , and quantity is X, then the firm perceives its curve as Df. Note that
Df is more elastic than Dp. It is actually the demand curve of the firm if all of
the rest continue to charge the same price. Df is more elastic because if one
firm reduces it’s prices and others do not, then the firm will be able to sell
more than its market share (given by Dp). Similarly, if a firm charges higher
prices while others do not, it will be able to sell less than what is given by Dp.
In monopolistic competition, there are a large number of firms and therefore
each firm thinks that its price changes will go unnoticed. That is why firms
behave naively.
9.3.1 Short-run Equilibrium
Consider the following figure where Dp and Df are as defined earlier
MC: firm's marginal cost curve
MR:marginal revenue curve corresponding to firm’s perceived demand curve
Consider for time being that all the firms are charging P . Therefore, all firms
have an incentive to charge P* and produce X*. But if all of them attempt to
charge P*, they could sell only X . Thus, the perceived demand curve will
shift to the left to intersect Dp at A. Firms now perceived demand curve is D'f .

43
Price and Output The MRf will also shift to the left and profit maximising output-price
Determination - I
combination will change.

MC
P

A
P*

Df
D' f

Dp

X X*
MR ' f
MR f
Fig. 9.2: Short-Run Equilibrium in Monopolistic Competition
The short-run equilibrium for the monopolistically competitive firms is shown
in the following figure. It can be seen that (Xe, Pe) is the equilibrium output
price combination, as MRf = MC holds and the firm is on its perceived
demand curve.
P

SRMC

Pe SRAC

Df

Dp
X
O
Xe

MR f

Fig. 9.3: Profit in Short-Run Monopolistic Competition

The dotted area shows the amount of profit accruing to each firm.
44
 Monopolistic
9.3.2 Long-run Equilibrium Competition

The short-run super normal profit will attract new firms to the product group
since there is no entry barrier (if in short run firms are incurring loss, they will
quit).
If more firms enter the product group, the proportionate demand curve will
shift to the left and would become steeper. This will continue till all the profit
is wiped out.
The long run equilibrium is depicted in the following figure:
P , AC , MR, MC
LRMC
LRAC

Pe

Df

Dp
X
O Xe

MR f

Fig. 9.4: Long Run Equilibrium in Monopolistic Competition

Each firm in the equilibrium (Xe, MRf, Pe) maximises its profit (MRf =
LRMC) and since LRAC is tangent to Df, there is no supernormal profit.
Therefore, there will be no entry or exit. Since (Xe, Pe) lies on Dp, the market
will clear.

9.4 CHAMBERLIN’S APPROACH TO

EQUILIBRIUM
1) Assumptions
The basic assumptions of Chamberlin’s large group model are the same as
those of pure competition with the exception of the homogeneous product.
They are as follows:
i) There are a large number of sellers and buyers in the ‘group’
ii) There is free entry and exit in the group
iii) The goal of the firm is profit maximisation both in the short-run and
long-run
45
Price and Output iv) The products of the seller are differentiated, yet they are close substitute
Determination - I
of each other
v) The prices of factors and technology are given
vi) The firm is assumed to behave as if it knew its demand and cost curves
with certainty
vii) The long-run consists of a number of identical short-run periods, which
are assumed to be independent of each other. It implies decisions of
present period do not affect that of the future. Neither they are affected by
that of past period’s.
viii) Finally, Chamberlin makes his ‘heroic’ assumption that both demand and
cost curves for all products are uniform throughout the group. This
requires that consumer preferences are evenly distributed among the
sellers and the cost conditions (even though products are differentiated)
are same in among the producers.
2) Cost Curves
The average variable cost (AVC), marginal cost (MC) and the average total
cost (ATC) curves are “U” shaped. This implies there is a single output level,
which is optional (note: the output level corresponding to the minimum point
of ATC is called the optimal output level).
Chamberlin introduced the concept of ‘selling cost’, which is incurred to
promote the sell of a product. He assumed that it is ‘U’ shaped. We will
discuss this concept in detail.
P
d

d
X
O
Fig. 9.5: Product Differentiation and Equilibrium of Firm
3) Demand Curves
While Sraffa first introduced that product differentiation could be a basis for
downward sloping demand curve, Chamberlin suggested that demand is not
determined by the prices alone. Apart from price, the selling activities and the
product itself are the major determinants of demand, according to Chamberlin.
46
 Monopolistic
The effect of product differentiation is that the producer has some discretion Competition
in the determination of prices. The producer is not a price taker but she enjoys
some degree of monopoly power.
4) Equilibrium of the Firm
As a result of product differentiation, the demand curve of an individual firm
is negatively sloped. If the firm increases its price, it will lose some of its
customers. However, by reducing price if will attract new customers, who
were customers to other firms.
Since there are large number of firms, if one firm reduces price the loss of
other firms (as they loose customer) will be negligible. Thus, other firms
might be indifferent to price charged by a single firm. The demand curve dd is
drawn on the above assumption that firms would not change or react to
individual firms price decisions.
In short, Chamberlin-firm acts like a monopolist and maximises its profit
equating MR and MC.
Chamberlin developed two different models of equilibrium.
In the first model, the existing firms are in short run equilibrium realising
supranational profits. They do not have any incentive to change their prices.
In the second model, it is assumed that the member of firms in the industry is
optimal and long run equilibrium is achieved by price adjustments.
The third model is a combination of the first two, where long run equilibrium
is achieved by price adjustments by the existing firms and by new entry.
9.4.1 Model 1
We assume that each firm is in short-run equilibrium maximising its profit.
P, C

LMC

LAC

PM B

A C

d'
X
O XM
MR '

Fig. 9.6: Equilibrium with Supernormal Profit

47
Price and Output dd´: firm’s demand curve
Determination - I
E: equilibrium point given by MR= MC.
PM: price corresponding to MR=MC.
XM: output corresponding to MR = MC
Area PM ACB: total profit
Since there are no entry barriers, new firms will enter and the demand curve
of the individual firm will shift down from dd´. However, the cost curves
would not change due to new entrants. For each entry, there will be a
corresponding shift in demand and for each shift, there will be a price
adjustment. This process will continue till there is supernormal profit. The
supernormal profits will be wiped out when the demand curve of the firms is
tangent to the average cost curve. Consequently, the profits earned will be
normal and there will be no further entries.
P, C

LMC
dE

LAC

PE

d E'
X
O XE MRE
Fig. 9.7: Equilibrium with Normal Profit

9.4.2 Model 2
In this model, it is assumed that the number of firms is such that there is no
supernormal profit. Therefore, there is no entry and exit.
In the model we consider a demand curve labelled DD´ shown in the
following Figure 9.8. The demand curve shows the actual sales of the firm at
each price after accounting for the adjustments in price made by other firms.
DD´ is called ‘share of the market demand curve: DD´ is obtained as a locus
of points of shifting dd´ curves, as competitions also simultaneously charge
their price. DD´ is steeper than dd´ curve (why?). A movement along DD´
shows changes in actual sales of existing firms as all of them adjust their price
simultaneously (and more importantly) identically, with their share remaining
constant. Shift in DD´ is caused by entry and exit of firms.
48
 Monopolistic
We start with the non-equilibrium position of a firm (X0, P0). The firm in an Competition
attempt to maximise profit lowers its price to P1 expecting to increase the sell.
However, all the firms adjust to this price change by lowering theirs by the
same proportion. As a result, d1d1´ shifts downward to d2 d2´ and instead of
X 1o , only X1 amount of output is sold (notice that: (X1, P1) is on DD´)

Again, in order to maximise profit, firm reduces its price once more to P2, but
as a consequence of the price adjustment by the others, it could sell only x2
(though wished to sell X10 ). Here we assume that the firm is naive and does
not take lessons from the past. This process ultimately stops when dd´ has
shifted enough to the left to be tangent to the LAC.
P, LAC , LMC D

d1

d2
P0

d3
LMC

P1 LAC

P2
Pe
d '1

d '2

d '3
D'
X
O Xe X '0
X0 X1
X2 MR
Fig. 9.8: Equilibrium in Monopolistic Competition

9.4.3 Model 3
Chamberlin argued that in practice equilibrium is achieved by price
adjustments of existing firms (as in model, 2) as well as new entry (as in
model 1). Equilibrium is stable if the dd´ is tangent to the average cost curve
and expected sales are equal to the actuals (i.e., the dd’ curve cuts the DD´ at
the point of tangency of dd´ and LAC).
We start with the point e1 (see Figure 9.9), where there is abnormal profit.
New firms are alternated until D1D1´ shifts to D3D3´. Some might take e2 as a
long run equilibrium with (P, X) price output combination since only normal
profit is earned these. However, this is not true. Each firm believes d1d1 is its
demand curve and if prices are lowered, output sold goes up and hence profit

49
Price and Output will increase. However, each firm having the same incentive to reduce price.
Determination - I
As a result, dd’ slides down and each firm realises a loss instead of profit
P, LAC , LMC
D2 D1
D3

d1 LMC
P e2

d2
C A e1
P'
d3
d1'
LAC
d4

E
P* d 2'

d3'

d 4'
* D2' '
D
3 D 1

X
O X X1 X2 X*

MR
Fig. 9.9: Equilibrium and Normal Profit
For example, see that at position d2d2´. The firm has reduced price to P´ but
others have not done similarly and X1 is produced with a total loss equal to the
shaded area CP’BA. Each firm still believes that it can achieve positive profit
by cutting price. The loss infact increases further as d2d2´ slides down along
D1D1´. The process would end when dd´ becomes tangent to the LAC. This
will happen if the firms produce X*. However, still there are too many firms
and their share is X2 (given by intersection of D3D3´ and d3d3´). Firms in order
to achieve X* (to maximize profit since at X*, MR=MC) reduce price. As a
result, d3 d3 slides down further to the left and with increasing losses. The
firms, which cannot bear this loss, quit D3D3 and move to the right to D2D2.
Exit will continue till d3d3’ becomes tangent to LAC, and D2D2´ cuts d3d3´ at
the point of tangency. The point E is the table equilibrium where (p*, X*) is
the equilibrium price quantity combination. Firms earn normal profit and no
entry or exit takes place.
Check Your Progress 1
1) Suppose there is a monopolistic competition market with 101 firms. The
market demand function is given by
k
Pk = 150 – xk – 0.02 ∑ x i
i =1
i≠k

50
 k
Monopolistic
∑ xi
i =1
→ all other firms reaction Competition

i≠k

The cost condition in each firm is the same,

Ck = 0.5 xk3 – 20xk2 + 270 xk
K =1,2, ……. 101,
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2) Find the short-run equilibrium P, x and profit.
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3) Find the long-run equilibrium for the above problem.
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4) Explain why the proportional demand function is steeper than the
perceived demand function.
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51
Price and Output 5) What is the difference between ‘industry’ and ’product group’? Can you
Determination - I
give an example of product group in the context of Indian market?
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9.5 SELLING COSTS

Under monopolistic competition, each firm incurs a certain amount of selling
cost to inform the customer about its product. A firm under monopolistic
competition has, therefore, three variables at its disposal, viz., price, quantity
and selling expenditure. Let us examine how selling cost enters into the
determination of equilibrium output of a firm and how the optimum amount of
selling cost is determined
Under monopolistic competition, quantity demanded will be a function of
both price and selling cost
i.e., X = X (S, P) where
S: selling cost
P: price
X: output demanded
Let us assume S is fixed at level So. Then we can get different combinations
of P and X for this level of S = So which satisfies the demand equation. Locus
of all such points is the AR (average revenue) curve. Thus, for each level of
selling cost, we will get an AR curve. This is shown in the following figure.
AB´: AR curve when S=So
A´B´: AR curve when S=S1
The figure shows that for selling the same quantity (Xo), the firm can charge
higher price (Po to P1) if it incurs higher selling costs (So to S1).
The selling cost is a function of price and quantity. Symbiotically, S = S(X, P)
Therefore, Profit (π) of a firm is
Π = P.X– C (X) – S (P, X) [where C= C(X) is the cost function]
First order conditions of profit maximisation are:
∂Π ∂S
= P – C´ (X) – =0 ...(1)
∂X ∂X
∂Π ∂S
=X– =0 ...(2)
∂P ∂P
∂S
From (1) P = C´ (C) + …(3)
∂X
Total Revenue R= P.X

52
 Monopolistic
∂R Competition
= P or, MR = P
∂X
∂S
From (3) MR = C´ (X) +
∂X
Thus, for profit maximisation marginal revenue with respect to output must be
equal to marginal production cost plus the marginal selling cost.
∂S
From X =
∂P
X may be called MR with respect to price. Thus, MR of a firm with respect to
price must be equal to MSC (marginal selling cost).
The following diagram explains the equilibrium of a firm
D0 D0: Demand curve for selling cost S = S0
D1D1: Demand curve for selling cost S = S1
D2D2: Demand curve for selling cost S = S2
MR0, MR1and MR2 are the marginal revenues for selling cost S0, S1 and S2
respectively. MC is the marginal cost curve.
The second order condition required that MR increases less rapidly than MC
both with respect to output and price
If the firm behaves like a monopolist, its profit maximizing output-price
combination is (Xo, Po), (X1, P1), (X2, P2) for selling cost So, S1 and S2,
respectively (these are obtained by equating MRo, MR1 and MR2 with MC).
P

A'

P'

P0

X
O X0 B B'
Fig. 9.10: Selling Cost and AR

53
Price and Output P, C
Determination - I
D2

MC
D1

P2

P1
D0

P0

X
O X0 X1 X2 D0 D1 D2
MR0 MR1 MR2
Fig. 9.11: Equilibrium in Monopolistic Competition with Selling Costs

For each of these combinations, we can determine the profit. Let these be πo,
π1, π2, respectively for S= So, S1and S2
Thus, we can find a functional relationship between profit and selling costs,
viz.,
π = π (S)
If we plot the profit on vertical axis and selling costs on horizontal axis, the
curve will look like the curve given in Figure 9.12.
Clearly, where the vertical difference between π (s) and the 450 line π (S) =S
is maximum,
i.e., π (S) – S
or, R – C (X) – S(X)
or, P.X – C (X) – S(X)
gives the optimum level of selling cost.
Thus, the optimum selling cost (S*) is obtained when the slope of π (S) is
equal to unity.

54
 Monopolistic
Competition

Gross profit

net profit

45°
S
O S*
Fig. 9.12: Relationship between Profit and Selling Costs

9.6 EXCESS CAPACITY UNDER MONOPOLISTIC

COMPETITION
Consider the long-run equilibrium for the firm under monopolistic
competition. At the equilibrium, the perceived demand curve is tangent to the
LRAC curve. Since the demand curve is downward sloping, the LRAC is also
downward sloping at this point. Unlike in perfect competition, the firm’s
equilibrium would never be at the minimum point of the LRAC curve. Hence,
it is argued that the firm’s output under monopolistic competition is not the
ideal output and there exists excess capacity, which is a wasteful use of
society’s resources.
LRAC
PC

SRAC1
SRAC2
PE

DD

X
O XE XM X1

Fig. 9.13: Decomposition of Excess Capacity

55
Price and Output Ideal output or the optimum output is associated with the minimum point of
Determination - I
the LRAC curve. The excess capacity is the difference between the optimal
output and the actual output attained by the firm in the long-run.
As Cassels argues, excess capacity in monopolistic competition could be
divided into two components. This is shown in figure 9.13:
OX1: Ideal or optimal output as it corresponds to minimum point of LRAC
curve
OXE: Long-run equilibrium output in a monopolistic competitive market
SRAC1: Short-run average cost curve corresponding to optimal plant for
output OXE
SRAC2: Short-run average cost curve corresponding optimal plant for output
OX1
Excess capacity is X E X1, which could be decomposed as
i) XM X1: due to not building the technically optimal plant
ii) XEXM: due to not operating the plant at the minimum point of the average
cost
Chamberlin, however, defended the high cost of output under monopolistic
competition with the shield of the product differentiation. According to him,
people may be willing to pay for the differentiation. Thus, the ideal output is
not that one corresponding to the minimum point of the LRAC curve. Of
course, excessive proliferation of products of different quality is a waste of
society’s resources, but the cost of monotonicity produced by having uniform
products has to be taken into account as well.
Check Your Progress 2
1) What it an ideal output? Why it is ideal?
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2) What is excess capacity? In a monopolistic competitive market, could
there be situation where firms are actually producing more than the ideal
output? Explain.
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3) Is excess capacity socially desirable? How Chamberlin argued in favour
of excess capacity?
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56
 Monopolistic
9.7 CRITICISM OF MONOPOLISTIC Competition

COMPETITION
The model of monopolistic competition was received very enthusiastically
and many economists termed it as “Chamberlin revolution” but there were
several serious attacks on this model
The downward sloping demand curves are derived from the assumption of
product differentiation. This is inconsistent with the assumption that cost
curves or demand conditions are the same for all the firms. If the output of
two firms is genuinely different, then the cost per unit of output is not really
comparable. Furthermore, the long run equilibrium of a firm with only normal
profit is logically incorrect. If the firm is providing a unique product and
making supernormal profits as a consequence, other firms can compete away
these profits only by providing the same product.
Another problem created by the introduction of product differentiation is the
difficulty to define the industry or the product group, e.g., tea, coffee, soft
drinks, beer, wine and liquor could form a product group according to
somebody but some others may reject. Thus, in monopolistic competition it is
not very clear where do we draw the line.
Finally, differentiated products are not produced by different firms. One single
firm may produce several differentiated products, which are close substitutes
of each other.
The monopolistic competition market structure is not useful for making any
prediction. Unlike the theories of perfect competition and monopoly, it does
not provide unambiguous predictions of the effect of changes in costs or
demand on the price of the product, size of the plant and the number of firms
operating in the industry.
All these discussions on monopolistic competition, however, do not mean that
it has been useless. For, it did raise a lot of issues previously overlooked
which prompted literature of selling costs, advertising, non price competition
etc.

9.8 LET US SUM UP

Monopoly and perfect competition are extreme forms of market and do not
resemble with reality. Chamberlin clubbed these two market structures
together and generated the concept of monopolistic competition.
The short-run and long-run equilibrium under monopolistic competition differ
considerably from those of monopoly and perfect competition. In short-run
there is excess profit and in the long-run that is wiped out as new firms enter
the market.
Most interestingly, under this market structure one could see that firms do not
operate at optimal plant size. This has huge significance to optimal use of
constrained resources.
9.9 KEY WORDS
Monopolistic Competition: A market structure characterised by many small
independent sellers of a differentiated product without barriers to entry.
Product Differentiation: The case where consumers perceive similar
products to have distinguished characteristics despite being substitutes of each
other.
57
Price and Output Product Group: A group of all the products, which are close substitutes of
Determination - I
each other.
Proportional Demand Curve: It is the demand curve facing a particular firm
in a product when all the firms charge the same price even though the
particular firm changes its prices.
Optimal output or Ideal Output: Output corresponding to the minimum
point of the LRAC curve.
Excess Capacity: The difference between optimal output and the output
attained by the firm in the long run equilibrium
Selling Costs: The cost incurred by a firm in order to increase the volume of
sales. This cost is different from production cost

9.10 SOME USEFUL BOOKS

Chamberlin, E.H (1933), The Theory of Monopolistic Competition,
Cambridge, MA: Harvard University Press.
Ferguson and Gould (1989), Microeconomic Theory, Irwin Publications in
economics;; Homewood, IL: Irwin.
Koutsoyiannis, A. (1979), Modern Microeconomics, Second edition, London:
Macmillian.

9.11 ANSWERS TO CHECK YOUR PROGRESS

Check Your Progress 1
k
1) Πk = pk.xk – ck (150 – xk – 0.02 ∑ x ) xk – 0.5xk + 20 xk – 270 xk
3 2
k
i =1
i≠k

First order condition for profit maximisation requires

∂Π k
=0
∂X K
k
⇒ 1.5xk2 – 38xk + 120 + 0.02 ∑ x k = 0
i =1
i≠k

In eqm. xi = xk ∀I (1, 101)

Therefore, the first order condition reduces to
1.5xk2 – 38xk + 120 + (100) (0.02) xk = 0
Solving this equation, we get xk = 4, 20
Second order condition requires
2
<0
X k2
Check yourself that at x = 20, second order condition holds but not at x=4
k
∴Pk = 150 – xk – 0.02 ∑x
i =1
k

i≠k

Since at eqm. xi = xk ∀i
∴Pk = 150 – xk – 0.02 (100). x
= 150 – 3 xk
58
 Monopolistic
= 90 [Therefore xk = 20] Competition

Πk = 400
2) As in the short run ΠK > 0, new firms will enter the industry
Πk = xk (150 – xk – 0.02 ∑ x ) – 0.5xk2 + 20 xk2 – 270 xk
i =1
i
i ≠k

(we sum over i =1 to n as the number of firms is unknown)

From first order condition
1.5 xk2 – 38xk + 120 + 0.02 ∑x
i=1
i =0
i ≠k

In eqm. xi= xk
1.5 X 2k – 38xk + 120 + 0.02 (n-1) Xk = 0 …(1)
In the long-run p = LAC
k
or, (150 – Xk – 0.02) ∑
i =1
x k = 0.5 Xk2 – 20 Xk + 1270
i≠k

or, 0.5 X 2k – 19 Xk + 120 + 0.02 (n-1) Xk = 0 {Therefore, in eqm. qi = qk ∀i}

X 2k – 19Xk = 0

or, Xk = 0 or, 19.

The second order condition requires

∂ 2Π k
= 38 – 3XK < 0
∂Π k2

which is satisfied for Xk = 19

Long-run equilibrium is obtained when Xk =19

Now putting Xk = 19 in equation (2)

0.5 (19)2 – 19 (19) + 120 + 0.02 (n-1) 19= 0

or, 0.5 x 361 – 361 + 120 + 0.38 (n-1 ) =0

or, 0.38 (n-1) = 60.5

6050
or, n = +1
38

= 160.2 ≅ 161

Thus, there will be 161 firms in the long-run

Check Your Progress 2

1) Do it yourself using Section 9.6 the output is ideal because the L AC is

minimum at that point.

2) For the first part use Section 9.6

59
Price and Output In monopolistic competition the demand curve is negatively sloped and
Determination - I
the long run equilibrium is achieved when perceived demand curve is
tangent to LAC. Since the perceived demand curve is negatively slope, it
would be tangent to LAC only at its falling portion. Therefore, a firm in
the long run would never produce more than the optimal output
3) Do it yourself using Section 9.6

9.12 EXERCISES
1) Illustrate a monopolistically competitive firm in short-run suffering a
loss. Describe the adjustment procedure in the long-run.
2) Which one between perceived and proportional demand curve determines
the firms choice of output and price? Why two must intersect at the
equilibrium point?
3) Is the soft drink market in India an example of monopolistic competition?
If not, give reasons.

60